Staff Legal Bulletin 14L: No More Nexus
Updated: Dec 5, 2021
[This is the second in a series of posts on SEC Staff Legal Bulletin No. 14L. You can read the first post here.]
Shouldn’t there be a nexus between a shareholder proposal and the company at which it is filed? The answer to this question seems obvious: “Yes, of course there should be.” But the most recent SEC Staff Legal Bulletin (SLB) 14L gives a different answer, which departs from the staff's own precedent. Let’s explore this subject.
What Is the Purpose of An Annual Meeting?
The purpose of an annual meeting, and the reason it is required by law, is for a company’s shareholders to elect the company’s directors and also to conduct other business that pertains to the company. The relevant Delaware statute (DGCL §211) says:
[A]n annual meeting of stockholders shall be held for the election of directors... Any other proper business may be transacted at the annual meeting.
Common law gives a lot of discretion to the board to determine what constitutes “proper” business. At a publicly traded company, other business typically includes ratifying the appointment of the company’s independent auditors (a vote that isn’t legally required) and giving the shareholders a “say on pay” (a vote that is legally required). Other matters that often get dealt with at an annual meeting are adopting amendments to the company’s certificate of incorporation and approving a new or amended equity-based incentive plan for the company’s employees (both legally required). All of these are matters that directly impact the company. So, why should shareholder proposals be any different?
The Staff Says
The SEC staff says in SLB 14L:
[W]e have found that focusing on the significance of a policy issue to a particular company has drawn the staff into factual considerations that do not advance the policy objectives behind the ordinary business exception. We have also concluded that such analysis did not yield consistent, predictable results…
[The] staff will no longer focus on determining the nexus between a policy issue and the company, but will instead focus on the social policy significance of the issue that is the subject of the shareholder proposal. In making this determination, the staff will consider whether the proposal raises issues with a broad societal impact, such that they transcend the ordinary business of the company.
The message I get from this is that the SEC staff feels it’s more difficult to make fact-based determinations about how a particular proposal would apply to a particular company than it is to make subjective determinations on what is a sufficiently significant social policy issue regardless of the company. That’s strange since I’m used to regulators preferring to make decisions on a case-by-case basis after considering specific facts and circumstances, regardless of the degree of difficulty. But I suppose it is easier to make a judgment call on something that doesn’t require definitive support, especially when you are not required to explain how you arrive at your conclusion and the party that doesn’t like it has no clear means for appeal. (More on that in a future post in this series on SLB 14L.)
Not Trump’s Nexus
The Staff is upfront in saying that this is a very intentional change in how they are going to analyze Rule 14a-8(i)(7), the “ordinary business” exclusion, by rescinding the three SLBs that immediately preceded SLB 14L. Those three SLBs were issued in 2017-2019, leading many commentators to characterize SLB 14L as a Biden-Gensler reversal of policies put in place by the Clayton SEC or Trump administration generally. As much as I found many policies coming out of the executive branch during the Trump presidency highly objectionable (and some downright offensive), we can’t blame Trump for this one. The “nexus” requirement was not created by Trump, Clayton or anyone else during 2016-2020. In fact, the SEC staff discussed the “nexus” requirement twice during the Obama presidency: in 2009 (SLB 14E) when Mary Schapiro was SEC Chair, and again in 2015 (SLB 14H) when Mary Jo White was Chair. Here’s the exact language from SLB 14E (footnote 4):
The determination as to whether a proposal deals with a matter relating to a company's ordinary business operations is made on a case-by-case basis, taking into account factors such as the nature of the proposal and the circumstances of the company to which it is directed. See Exchange Act Release No. 40018 (May 21, 1998) [63 FR 29106].
And here's the exact language from SLB 14H (footnote 32):
Whether the significant policy exception applies depends, in part, on the connection between the significant policy issue and the company’s business operations. See Staff Legal Bulletin No. 14E (Oct. 27, 2009) (stating that a proposal generally will not be excludable “as long as a sufficient nexus exists between the nature of the proposal and the company”).
But even well before 2009, it was widely acknowledged within the securities bar that there needed to be a connection between the subject of a shareholder proposal and the company’s business, including a proposal about a significant policy issue.
Let's go back even further to the SEC’s 1976 release (No. 34-12999 (41 Fed. Reg. 55873)), from which the significant policy exception to the ordinary business exclusion originated. It said:
Specifically, the term “ordinary business operations” has been deemed on occasion to include certain matters which have significant policy, economic or other implications inherent in them. For instance, a proposal that a utility company not construct a proposed nuclear power plant has in the past been considered excludable… In retrospect, however, it seems apparent that the economic and safety considerations attendant to nuclear power plants are of such magnitude that a determination whether to construct one is not an “ordinary” business matter. Accordingly, proposals of that nature, as well as others that have major implications, will in the future be considered beyond the realm of an issuer’s ordinary business operations, and future interpretative letters of the Commission’s staff will reflect that view.
While the 1976 release (when Gerald Ford was POTUS and Roderick Hills was SEC Chair) does not specifically refer to a "nexus" requirement, clearly the example it gives shows the SEC's intent to look for a relation between policy issue and company, in this example nuclear power generation at a company in the energy generation business. If some shareholder, for whatever bizarre reason, filed a proposal at a pharmaceutical company asking that the company not construct a nuclear power plant, it would make absolutely no sense, whether in 1976 or 2022, for the SEC to force the pharma company to include it in its proxy statement.
Now that the staff is saying that there doesn't have to be a nexus between the significant policy issue being raised and the company's business, can shareholders force shareholder votes on pretty much any significant policy issue at any company, whether it's abortion, critical race theory, vaccine requirements, or gun control? I’ll go deeper on this in a future post in this series on SLB 14L, but first I’ll give you something to consider.
I used to work at a company in the business of manufacturing and marketing pharmaceuticals, medical devices, and consumer health products. We received a lot of shareholder proposals asking the company to support universal healthcare legislation. Clearly a universal healthcare proposal (A) addressed a significant policy issue, especially in the early years of the Obama administration when many of these proposals were filed, and (B) had a nexus to a healthcare company that was smack in the middle of discussions on what would become the Affordable Care Act.
Would a universal healthcare proposal be appropriate for a shareholder vote at a company not in the healthcare space, say a tire manufacturing company? A tire company provides health insurance coverage to its employees, so if the US were to move to a universal healthcare system, it would definitely impact that company. But a universal healthcare proposal would be totally out of place in the proxy statement for the annual meeting of a company with zero connection to the healthcare industry, right? If you take away any consideration of a nexus between the proposal and the company’s business, a universal healthcare proposal would be fair game at a tire company and every other company. That doesn’t seem like the correct outcome.
A Shareholder Right?
The point of allowing shareholders to make proposals to be voted on at annual meetings is to give shareholders a voice on how the company is managed at a very high level. This is an important element of the system through which a corporation is governed and the reason why the SEC gets involved in protecting the shareholders’ ability to have their proposals appear in companies’ proxy materials. But the staff goes even further when it says:
[The significant social policy] exception is essential for preserving shareholders’ right to bring important issues before other shareholders by means of the company's proxy statement.
What specific "right" are they talking about? If they are referring to something under state laws, federal statutes, or SEC regulations, they should cite it. Calling something a "right" implies it was specifically authorized by someone.
The bottom line here is that the annual meeting is for shareholders of a company to vote on items of business that pertain to that company, starting with the election of the directors. It is not supposed to be an open forum for anything that anyone who happens to be a shareholder wants to talk about. Most companies provide time for open mic questions and comments during a Q&A session (which isn’t legally required). That's really the time and place for it, and even then, companies ask that shareholders keep their comments relevant to the company. You can quibble with how general Q&A sessions are handled, but that’s a different subject. When it comes to shareholder proposals, the proxy statement is a disclosure document for formal items of business… related the company. I think the SEC staff got it wrong on the nexus question.